Don’t blame regulation for your credit card bill

Let’s nip this one in the bud, shall we? Here’s a headline from David Morrison at Credit Union Times: “CARD Act Has Kept Card Interest Rates High, Analyst Claims”. He’s talking about a 16-page paper from Tim Kolk, who’ll email you a copy if you ask him nicely and/or drop my name. But here’s the gist of his argument:

Since 2008, benchmark auto loan rates and mortgage rates have declined by 30% and 42% respectively while credit card interest rates have declined by only 3%.

If credit card interest rates had declined in an amount proportional to the mid-point decline of other lending products, then average credit card interest rates would have declined by 410 basis points since 2008.

The additional interest costs of these higher-than-otherwise expected interest rates are estimated at $28 billion annually.

Kolk even has a handy chart:

This seems clear, no? The spread between credit card rates and the prime rate used to be low, and then the CARD Act was introduced, and now it’s high. What’s more, says Kolk, “the great majority of the above rate increase can be attributed to CARD Act”, which introduced a host of consumer protections for credit card holders.

There’s no doubt that $28 billion is a lot of money, and that if Kolk is right, that would be a huge black eye and unintended consequence of the CARD Act. Fortunately, he’s not right, and there are three ways of showing that.

First, let’s zoom out a bit and show what’s happened to credit-card interest rates, and the prime rate, over the past 17 years:

What you can see here is that credit-card interest rates are much less volatile than the prime rate: they stay in a pretty narrow band between 12% and 16%, even as the prime rate has a much greater range. And while there are lots of relatively small moves up and down in credit-card rates, they don’t bear much relation to what’s happening with the prime rate, which moves slowly.

To put it another way: the prime rate is locked directly to the Fed funds rate: it’s basically set by the Fed. Credit card rates, by contrast, are not: the Fed has much less control over them. And so you’d expect the spread between the two rates to be pretty volatile. Which it is! What you might not expect, however, after reading Kolk’s paper, is that the spread came down after the CARD act came into force. Here’s the spread between the two interest rates: the red triangle marks the point at which the CARD Act was signed into law.

This is not the chart you’d expect from reading Kolk’s report — which, incidentally, never mentions when the CARD Act actually started taking effect. What you see here is a lot of more-or-less random ups and downs: for instance, the all-time low in the spread, of 552bp in May 2000, took place when the prime rate was a whopping 9.24%. Kolk would have you believe that this series should go down when the prime rate goes down, but in fact it’s more likely to go down when the prime rate goes up.

The one very clear trend — as you’d expect — is that when the country is in the midst of a gruesome credit crunch, the spread on credit-card interest rates goes way up. But then, after the CARD Act was introduced and liquidity started coming back into the system again, the spread started falling.

In any event, it’s just intuitively wrong that credit-card interest rates would mirror the Fed funds rate. The Fed does have a pretty strong effect on mortgage rates, and car-loan rates, because people shop for mortgages and car loans on the basis of where they can get the best rate. But credit cards don’t work like that. Their interest rates change in unpredictable ways, and in any event, when most people get a new credit card, they’re either taking advantage of a limited-time introductory offer, or else they’re fully intending never to pay any interest at all.

Credit card companies have a fiduciary responsibility to maximize their profits, and that in turn means they have to maximize the interest rates they charge. They’re good at doing that: like a magician, they force your attention to one place, full of shiny objects and bells and whistles, while quietly picking your pocket at the same time. They also take full advantage of behavioral economics, and the way in which we convince ourselves that we will be very fiscally prudent in the future, even if we weren’t in the past. They have every incentive to behave this way, and that’s exactly what they do, whether the CARD Act is in force or not.

Kolk has a series of perfectly valid points demonstrating that the CARD Act has reduced the amount of money that credit card issuers can make from their cards. That was entirely deliberate and intended. But there’s a common fallacy that if a company loses money in one area, it has to “make it up” somewhere else. In reality, the person in charge of that other area was always under pressure to maximize profits, even before the first area ceased to be so profitable.

In order for it to make sense for a credit card company to lower its interest rates, you need something of a perfect storm: not just lower rates, but also an environment where you want to increase your volumes, and an environment where you can gain new customers by advertising lower rates. Right now we’re just not there: credit card issuers aren’t so keen for new customers that they’re willing to lower their rates to get them, and in any case the people getting credit cards aren’t recklessly rolling over their balances, like they did before the crisis: instead, they’re still largely in deleveraging mode.

You wouldn’t expect credit card companies to be competing on interest rates, then — and they’re not. But that’s got nothing to do with the CARD Act. And regardless, as my chart shows, spreads and rates are both down significantly from when the CARD Act was introduced. Sometimes, regulation really does hit the companies it’s intended to hit, without much collateral damage.